MagicJack Feeling the Short Sellers Now as Stock Plunges

By Gabrielle Coppola -
Jun 1, 2014

When Tim McDonald, the chief
operating officer of MagicJack VocalTec Ltd. (CALL), talks about the
challenge of transforming his voice-over-Internet technology
company, he likes to compare himself to Nik Wallenda, the
daredevil who crossed Niagara Falls on a tightrope.

“Every single day we’re focused on crossing that high wire
to get to the other side,” McDonald said in a May 23 interview
at Bloomberg headquarters in New York. “What we see on the
other side is a growth market.”

Investors aren’t convinced. MagicJack’s shares sank 18
percent in May, the biggest drop in 16 months, while short
interest in the stock is still more than five times the average
of companies on the Nasdaq Composite Index. McDonald and chief
executive officer Gerald Vento are betting a revamp of
MagicJack’s mobile application will allow it to benefit from the
same business model of free communication services offered by
WhatsApp Inc., which Facebook Inc. bought for $19 billion.

“People think that their growth and margins are
unsustainable even as management has rolled out new initiatives
that have produced some fair results,” Yousef Abbasi, a market
strategist at JonesTrading Institutional Services LLC in New
York, said in an e-mail. “There’s high competition and
innovation, and the management team has to keep up with that.”

MagicJack, with headquarters in Netanya, Israel and West
Palm Beach, Florida, is changing its pricing and marketing
strategy to more tightly link the use of its MagicJack device
and mobile app. It’s also working with retailers including Wal-Mart Stores Inc. for a June push to unveil the changes. The
goal, according to McDonald, is to market MagicJack as a
provider of cheap mobile number and voice services, instead of a
“gadget business.”

‘Value Proposition’

Revenue declined 4 percent in the first quarter to $35.3
million, while the number of device subscribers fell 2 percent
from the prior quarter, the company said on a May 12 conference
call with analysts.

The dip in sales helped drive last month’s stock rout,
which was the worst on the Bloomberg index of the largest New
York-traded Israeli companies. The company, which burned short-sellers with a 78 percent rally in the first three months of the
year, has dropped 31 percent this quarter. Israel’s benchmark
TA-25 index gained 0.3 percent in Tel Aviv today.

The company’s earnings results in the first half of the
year won’t reflect the kind of growth MagicJack is aiming for
with its strategy shift, according to McDonald.

“We’re changing the value proposition of the company, and
that value proposition and that new offer is yet to be tested in
the marketplace,” he said.

Business Model

While short sellers are paring back their positions, the
amount of stock borrowed to profit from declines represents
about 16 percent of shares outstanding, compared with an average
of 3 percent on the Nasdaq Composite Index. That’s down from a
record 22 percent of shares outstanding on May 16, according to
Markit, a London-based provider of financial information.

McDonald likens his task of transforming MagicJack’s
business model while contending with short-sellers to a high-wire walker getting hit by fire hoses.

“The guys with the fire hoses trying to spray Nik Wallenda
off of the tightrope, they see the gadget business, and they say
the gadget business is dying,” he said. “What we’re seeing on
the other side is, no, we have a service business, which sells
numbers and voice services, at home and on the go.”

App Users

MagicJack’s monthly active unique app users increased to
3.5 million in the first quarter, from 3.3 million at the end of
2013, according to the May 12 conference call with investors.
The company expects to generate app-only revenue in the second
half of 2014. McDonald stresses his app is different because it
enables calls to any phone line, not just between users of the
same app.

Even if management is successful in changing the business
model, competition from other mobile apps like WhatsApp, Rakuten
Inc. (4755)’s Viber Internet messaging system or Apple Inc.’s FaceTime
video-chatting service still spur investor skepticism, Abbasi
said.

“Investors see the business as a lot more commoditized,”
he said. “Why not use Viber on your cell phone, or FaceTime for
voice over the Internet? All of those are free.”